As Canada enters its 2013 proxy season, there are a number of new realities that companies will have to prepare for.
As Canada enters its 2013 proxy season, there are a number of new realities that companies will have to prepare for. Significant policy changes at proxy advisory firms ISS and Glass Lewis, as well as the implementation of new regulations that demand greater levels of disclosure, mean greater accountability for directors and the increased possibility of takeover attempts at companies both large and small. Here we present a run-down of the key issues that companies must be aware of if they wish to stay ahead of these developments.
More takeover attempts
According to Fasken Martineau’s 2013 Canadian proxy contest study, investors won 54 percent of the board-related proxy battles over a five-year period from 2003 to 2007. Dissidents have been either winning proxy fights or forcing negotiations in their favor for the last five years, and the report states that those using a high-stakes approach, including having ‘more skin in the game’, seeking a full change in the boardroom or waging a long, public campaign, are more likely to win their proxy contests. Experts predict that such trends will continue.
Expect shareholder activism to increase this year on the heels of Pershing Square’s 2012 takeover of Canadian Pacific Railroad and significant shareholder actions against other companies such as Telus and Continental Precious Minerals. Experts believe takeover attempts in Canada will grow, fueled by continued weak stock performance that is emboldening investors to challenge management and pushing the board to improve returns.
‘There is going to be a ramping-up of takeovers in the Canadian space within the next couple of years. Some of them will be opportunistic, some will be out of frustration and anger and some will make good sense,’ says Glenn Keeling, managing director of CST Phoenix Advisors. ‘You’ve got a very vocal shareholder community, and there is a lot of talk about who will initiate these fights. You are seeing some of the Canadian institutional community starting to get a little more active – not being afraid to step out from behind the spotlight and show their colors.’
Traditionally, institutional investors in Canada have been a relatively passive bunch, but with American hedge funds and other activist investors aggressively targeting Canadian companies, there may be a shift occurring.
‘I think activism is still going to be led by those individuals who have a history of doing so, but you are seeing institutions engage on an activist level,’ says David Salmon, senior vice president of national sales and marketing for Laurel Hill Advisory Group. He notes that although Canadian institutions rarely lead hostile takeovers, they are more prepared than ever to join activist investors in a takeover attempt if they believe that it will improve their overall returns.
Director voting
The recent amendments to the Toronto Stock Exchange (TSX) listing rules basically eliminate slate voting for most companies, and the policy changes from ISS and Glass Lewis mean increased levels of accountability for individual directors. ISS is recommending withhold votes for all directors nominated on a slate ballot. While Glass Lewis doesn’t reject slate voting outright, it does have a laundry list of transgressions that can trigger a withhold vote from an individual director; ‘if significant issues exist concerning any of the nominees,’ Glass Lewis states, ‘we will recommend withholding votes from the entire slate.’ This means that all directors must ensure they are ‘squeaky clean’ at all times, lest they run the risk of bringing the entire board under scrutiny.
The scrutiny on directors has been ratcheted up anyway, now that TSX companies are required to disclose the voting support that each director receives. Salmon says this type of disclosure could be problematic for companies that have governance problems. Historically, there is low voter turnout for director elections – typically 25 percent to 30 percent. If an individual director is having trouble carrying supportive votes above 75 percent, Salmon hypothesizes, ‘then an activist might reason, If I can line up some of the passive activists and purchase up to 9.9 percent [of the stock], before you know it, I’ve got a significant portion of that vote and I don’t need to go much further to overcome the typical 25 percent to 30 percent that management normally gets [to defeat that director and win a board seat].
Under the new regulations, any director who does not receive significant support in a vote or who receives a withhold vote for some other reason will run the risk of becoming a lightning rod for activist investors. Companies should take steps to minimize any potential drama that might be caused by their directors.
Executive compensation
Few will be surprised to learn that compensation will continue to be an area of concern during proxy season. Glass Lewis has chosen to focus on four areas when reviewing say-on-pay proposals:
• The overall design and structure of the company’s executive compensation program
• The quality and content of the company’s disclosure
• The quantum paid to executives
• The link between compensation and performance, as indicated by the company’s pay-for-performance practices.
ISS has indicated that it will vote against or withhold votes for equity-based compensation plans if:
• There is a pay-for-performance disconnect between the chief executive’s total compensation and the company’s stock performance
• The chief executive’s total compensation has increased from the prior year
• Where an equity-based plan is on the agenda, the main source of the increase (over half) is equity-based, and the CEO is a participant in the equity proposal.
Making sure your organization avoids the minefields laid out by each proxy advisory firm can be a difficult challenge. ‘We’ve seen a lot more creativity in the compensation schemes, but also, a lot more criticism of executive pay out in the marketplace,’ says Keeling.
Compensation can involve stock options, equity grants, salary and a range of other incentives. Discussions on this issue will be particularly prickly this year because so many companies continue to struggle. Companies with compensation plans that increase executive pay even as share price performance has suffered may be opening themselves up for extra scrutiny from activist investors.
Keeling suggests that companies be prepared to defend their compensation plans by analyzing their pay plans versus those of other, similar companies in the same industry or sector. Finding the proper peer group should help companies make a better argument for how CEO pay is aligned properly with the company’s performance. Companies will also have to decide if they want to make a case for having to pay higher compensation in order to attract and retain top executive talent. The argument is that you may have to pay more to attract high-level executives capable of successfully running a company in what is largely considered a ‘depressed-share-price environment.’
Since Canada has a disproportionate number of mining companies, Keeling notes that ‘certain companies have a hard time finding peers to effectively and realistically compare themselves to.’ Unfortunately, that fact won’t let them off the hook. Companies will still have to explain why their compensation plans strike the right balance between pay and company performance.
Governance issues
Canadian companies face a more intense review from institutional investors when it comes to governance best practices this year.
‘It’s been a challenging market; people are looking at all aspects of consideration, and corporate governance is really factoring in now,’ says Salmon. He explains that institutional investors are scrutinizing the governance practices of companies because ‘this mitigates risk, and if they see risk that isn’t being addressed appropriately, they want to make sure that it is.’
While shareholder concerns over environmental, sustainability and governance reporting aren’t likely to trigger a proxy fight for control of the company, such matters do provide areas for discussion and negotiation that can help management win over investors before a takeover attempt takes place. There may be other governance issues that investors might want to start a fight over, and companies need to identify these concerns early on so that amicable solutions can be found.
Salmon says he takes companies through a corporate governance review and a shareholder identification process to get them prepared for possible conflicts. ‘We are basically identifying vulnerabilities, understanding where you are susceptible from a governance perspective and from a shareholder identification perspective – then it becomes a board discussion.’
Salmon explains that the goal is not to force the board to change its governance policies, but to have a thorough and open discussion to determine if the policies in place or being pursued are truly best suited for the company. The board should be able to explain to management and/or regulators why a policy is, or isn’t, best suited for the organization. ‘It’s really just about getting out in front of the curve,’ Salmon says.
Another governance issue that is at the forefront this year is the matter of ‘advance notice agreements’ for nominating candidates for election to the board. Both Glass Lewis and ISS say they will generally support advance notice polices that require nominating shareholders to provide notice of not less than 30 days but not more than 65 days prior to the annual meeting.
Many companies are excited about the possible cost savings that advance notice may provide, but experts say there are still several legal issues that must be resolved before the policy can be put into full usage.
Staying engaged
Every proxy solicitation firm is advising issuers to engage their shareholders in a year-round campaign to keep them informed and to enhance relationships in case conflicts arise.
‘Simply sending out a proxy circular one time a year or having your CEO do a roadshow one time a year is not an engagement process,’ says Salmon. ‘Make sure you are out there engaging with your entire shareholder base regularly.’
Salmon emphasizes the importance of knowing your shareholders because ‘once you know who your shareholders are you can make sure you are appropriately targeting them – similar to a political campaign. You speak to different constituents in different ways, and you want to make sure you are speaking to them in their language.’
Salmon also suggests that companies consider writing a quarterly ‘dear shareholder’ letter to communicate with all shareholders, regularly informing them what the current issues are and how the company is being run. One of the benefits of such a letter is that ‘you keep your retail shareholders apprized of what’s going on so they know who your CEO is before he’s calling to get a vote.’
Keeling emphasizes the importance of engagement as well. ‘Regular dialogue, not just with your institutions but with your retail shareholder base, knowing them and making certain you are delivering good information about where you’re at – these are probably some of the best defense strategies against takeover,’ he says.
